FINANCIAL PEFORMANCE MEASUREMENTS:
I used several different metrics in measuring a company’s performance over a five year period, including:
- STOCK PRICE GROWTH: Often considered the most fundamental indicator of shareholder performance. This calculates the percentage growth of a common stock share over the period.
- REVENUE GROWTH: Revenue is the total sales (“top-line”) of the company.
- GROSS MARGIN GROWTH: Gross Margin subtracts the Cost of Goods Sold from Revenue. When this sum is divided by total revenue the result is Gross Margin Percentage. The cost of goods sold subtracts direct cost associated with producing the product but excludes items such as unallocated administrative expense.
- NET INCOME GROWTH: Net income (“bottom-line”) is equal to income from revenue after subtracting all expenses, including tax and interest.
- CASH FLOW GROWTH: Cash flow is the amount of cash being received and paid over time from the following activity sources: Operational, Investing and Financing.
- EARNINGS PER SHARE (EPS) GROWTH: EPS measures a company’s profit over the number of its weighted average common shares of stock.
I selected several financial performance indicators to discount the occurrence of any unusual activity that may skew the results of a company. For example, a company may have very strong results as reflected in their revenue growth and stock price. However, the same company may incur an extraordinary loss which negatively impacts net income, but is largely overlooked by investors because it is considered unusual in nature and infrequent in occurrence.
RESEARCH:
- INDUSTRY – MEDIA NETWORKS
DIVERSIFED COMPANY: Walt Disney Corporation
Although many associate the Walt Disney Corporation solely with theme amusement parks, they are a well diversified company. The primary business segments are as follows:
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Media Networks: This business segment contributed the most to profits last year, and represented 42% of their overall 2007 revenue for the company. This segment includes the ABC television network, along with ten other owned television stations such as ESPN and the Disney Channel. In addition to television programming, Disney also owns 46 radio stations.
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Park & Resorts: This is the 2nd largest business segment. This segment includes the familiar theme park resorts and hotels located in both Florida and California. Disney also maintains an equity stake in theme parks located in France, Japan and Hong Kong.
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Studio Entertainment: This segment produces and distributes motion pictures. Movies are distributed through Walt Disney Pictures, Touchtone Pictures; and Miramax production studios. Disney completed an all stock acquisition of a digital animation studio (Pixar) in 2006.
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Consumer Products: This segment includes the licensing revenue of the Disney name and images. The Disney Store is owned and operated in Europe, and franchised in North America and Japan. Disney also produces books, magazines, software and video game products.
CORE COMPANY: CBS Corporation
CBS describes itself as a mass media entity but it is primarily a television network based company. Their television network business segment accounts for approximately two-thirds of their overall revenue. The familiar CBS television stations primarily derive their revenue from advertising sold during their programming. CBS also owns the Showtime cable network and has a 50% equity interest in the CW network with Warner Brothers Entertainment. CBS owns and operates 140 radio stations and the book publisher Simon & Schuster. The publishing segment only accounts for about 6% of overall revenue, therefore I do not consider the company “diversified”. CBS was spun-off from Viacom at the end of 2005.
STOCK PERFORMANCE:
Due to the aforementioned CBS spin-off from Viacom at the end of 2005, the below stock price comparison begins in early 2006 (i.e., earlier data is not available). The period examined is 1/3/06 through 11/17/08. During that period CBS lost 81.7% of their share value, dropping from $27.23 down to $4.98. Walt Disney’s decline was only 12.9%, from $24.74 down to $21.12. Disney stock price has outperformed that of CBS.
(TICKER SYMBOL NOTE: DIS = DISNEY & CBS = CBS)
PERFORMANCE METRICS:
(* Stock Growth Rate is from 1/3/06 – 11/17/08. All other measures are 5-year growth rates)
CONCLUSION (MEDIA NETWORKS INDUSRY): The diversified company (Walt Disney Corp) outperformed the core company (CBS Corp) in all performance metrics measured for the Media Network industry sample.
- INDUSTRY – SOFT DRINKS
DIVERSIFED COMPANY: PepsiCo
Although primarily in the soft drink market, Pepsi maintains a diverse product line which also includes an assortment of non-carbonated beverages. Most notably, Pepsi has diversified into salty and sweet snacks, as well as other food products. Pepsi used to be even more diversified into the fast food restaurant business; however they spun-off the Taco Bell, KFC, and Pizza Hut restaurant brands in 1997. Pepsi’s current food brands include Frito-Lay and Quaker Foods. Frito-Lay produces snacks such as Doritos, Cheetos, Ruffles potato chips, Rold Gold pretzels, Grandma’s cookies, and SunChips. Quaker Foods manufactures cereals, oatmeal, syrups and pasta. Going forward Pepsi will group their operations into the following business units: PepsiCo America Foods; PepsiCo America Beverages; and PepsiCo International. However, the PepsiCo business segments as of 2007 were grouped as follows:
(note: the designation “N.A.” in the above chart legend stands for “North America”)
CORE COMPANY: The Coca-Cola Company
Coca-Cola is a preeminent manufacturer and marketer of soft drinks and other non-carbonated beverages. Unlike Pepsi, Coke has not significantly diversified into other markets, and has chosen to keep its focus on the beverage industry. Coke did plan a joint venture with Proctor & Gamble in 2001 to sell snack foods, but the venture was scuttled. In 2000, the Coca-Cola CEO had agreed to purchase Quaker Oats for $15.75 billion, but several directors stopped the deal, arguing the price tag was too steep. Quaker was then acquired by rival Pepsi.
STOCK PERFORMANCE:
The five year period examined is 11/24/03 through 11/17/08. During that period Coca-Cola lost 5.4% of their share value, dropping from $46.50 down to $44.00. Pepsi’s stock gained 15.5% over the same period, from $48.12 to $54.59. The Pepsi stock price has outperformed that of Coca-Cola.
(TICKER SYMBOL NOTE: KO = COCA-COLA & PEP = PEPSI)
PERFORMANCE METRICS:
CONCLUSION (SOFT DRINK INDUSTRY): The diversified company (PepsiCo) outperformed the core company (Coca-Cola) in all but one performance metric measured for the Soft Drink industry sample.
- INDUSTRY – PERSONAL COMPUTERS
DIVERSIFED COMPANY: Apple Inc.
Apple designs, manufactures, and markets personal computers. However, they have also diversified into the following markets: portable digital music players (i.e., iPods); mobile telephones (i.e., iPhone); software (e.g., Leopard Operating System); services; peripherals; and networking solutions. The company sells hardware via both their online website and retail stores. Apple also sells digital content (e.g., music, movies, audio books, television shows) through their online iTunes store. They are widely considered to be one of the most innovative manufacturers and marketers in the industry. Apple’s latest fiscal year end revenues are segmented as follows:
Note 1: The above chart represents fiscal year ending 9/30/08.
Note 2: The $14,276m of Mac computer sales includes both desktops ($5,603m) & portables ($8,673m)
CORE COMPANY: Dell Inc.
Dell is primarily involved in the business of manufacturing and marketing personal computers. Although they are somewhat diversified into other areas (e.g., servers, storage, software, peripherals) they are less diversified than Apple. The sale of personal computers makes up over 60% of Dell’s overall revenue, as opposed to less than 45% for Apple. Desktops and laptop computers accounted for $37m of Dell’s total revenue of $61m for their fiscal year ending February 1, 2008.
STOCK PERFORMANCE:
The five year period examined is 11/24/03 through 11/10/08. During that period Dell lost 68.5% of their share value, dropping from $34.57 down to $10.89. Apple’s stock gained a very impressive 663.5% over the same period, from $10.45 to $90.24. The Apple stock price has clearly outperformed that of Dell.
(TICKER SYMBOL NOTE: AAPL = APPLE & DELL = DELL)
PERFORMANCE METRICS:
CONCLUSION (PERSONAL COMPUTER INDUSTRY): The diversified company (Apple) outperformed the core company (Dell) in all performance metrics measured for the Personal Computers industry sample.
- INDUSTRY – FINANCIAL SERVICES
DIVERSIFED COMPANY: General Electric Co.
Historically, most considered General Electric (GE) to be primarily a manufacturer of appliances and other consumer durables. GE has spun-off many of their older, less profitable manufacturing operations over the years, and is continually seeking new high margins industries to invest in. Today, GE is a very widely diversified conglomerate. Many may be surprised to discover that GE’s main revenue source is now financial services, when combining both of their “Commercial Finance” and “GE Money” business segments together. GE’s commercial finance segment’s growth was helped by several significant asset leasing business acquisitions in 2007. GE did decide to sell its U.S. mortgage business from its “GE Money” portfolio due to the recent troubles in the subprime market. General Electric’s “Infrastructure” segment may, at first glance, appear to be GE’s largest business. However, the Infrastructure segment actually consists of several unrelated smaller sub-segments including: Aviation, Energy, Oil & Gas, and Transportation. The NBC Universal business segment represents GE’s foray into becoming a leading presence in the mass media industry. The Healthcare and Industrial segments produce items such as surgical imaging equipment and high end consumer appliances, respectively. A complete summary of GE’s operations is beyond the scope of this paper; however their revenues are segmented as follows:
Note 1: The Commercial Finance and GE Money business segments combine to account for 35% of overall 2007 revenue.
Note 2: The Infrastructure business segment consists of a number of smaller sub-segments such as Aviation, Energy, Oil & Gas, and Transportation.
CORE COMPANY: Citigroup Inc.
Citigroup is a large financial services company with a long history which dates back as far as 1812. Approximately 70% of their revenue is derived from what call “Global Consumer Finance”. This involves several types of both U.S. and international lending, such as: credit cards, consumer finance/lending, and retail banking. They have grown larger via acquisitions over the years including those of Smith Barney and Saloman Brothers. However, there most high profile acquisition was that of Travelers. Citicorp and Travelers merged in 1998 to form Citigroup. Citigroup has fallen on extremely difficult times recently with current economic crisis. Their share price declined 87.2% between the first of this year and November 24, 2008. The stock price rebounded slightly after the U.S. government announced a rescue program for Citigroup. The government agreed to inject $20 billion of capital into Citigroup and absorb up to $249 million in potential losses on real estate loans and securities held by the bank. Despite this bailout program, the future for Citigroup remains uncertain. Although Citigroup was particularly hard hit by the severe credit crunch, I believe any relatively undiversified financial service company could have been substituted into this analysis with somewhat similar, comparative results.
STOCK PERFORMANCE:
The five year period examined is 12/1/03 through 11/17/08. During that period Citigroup lost 91.9% of their share value, dropping from $46.58 down to $42.81. General Electric’s stock lost 51.8% over the same period, from $29.10 to $14.03. Although, both companies have lost share price value over the past five years, particularly during this year’s economic crisis, Citigroup has fared much worse than General Electric (the more diversified company).
(TICKER SYMBOL NOTE: GE = GENERAL ELECTRIC & C = CITIGROUP)
PERFORMANCE METRICS:
CONCLUSION (FINANCIAL SERVICES INDUSTRY): The diversified company (GE) outperformed the core company (Citigroup) in all but one of the performance metrics measured for the Financial Services industry sample. Perhaps no industry better calls into question the business strategy of “putting all your eggs into one basket” as the financial services industry during the current economic meltdown.
- INDUSTRY – HOME FIXTURES
DIVERSIFED COMPANY: Fortune Brands, Inc.
Fortune Brands is a diversified company which manufactures a range of familiar name brand products. Golf is the smallest of their 3 segments with 16% of the overall company revenue. Some of the familiar golf brands which Fortune Brands owns are: Titleist, FootJoy and Cobra. Their share of the golf ball market has been growing. Their next largest segment in terms of revenue is Spirits. Some of the well known brands of spirits they produce are: Jim Beam bourbon, Canadian Club whiskey, Courvoisier cognac, Sauza tequila, Maker’s Mark bourbon, and Teacher’s scotch. Although only 2nd in terms of revenue, spirits are a high margin product segment which provide the most operating income (53%). Fortune Brand’s largest revenue segment is called “Home & Hardware”. This segment included Moen products which are the number one brand for Fortune, followed by Jim Beam and Titleist. Moen is the number one Fawcett brand in North America. This segment also includes Therma-Tru Doors, Omega Cabinetry, Aristokraft Cabinetry, and Simonton Windows; the latter of which they acquired in 2006. Master Lock, the leading producer of padlocks worldwide, is also in this segment. The revenue percentages for each of Fortune Brand’s business segment is as follows:
CORE COMPANY: Masco Corporation
Although Masco’s total sales of $11.8 billion are higher than Fortune Brand’s $8.6 billion; Masco is a less diversified company. Masco specializes on home fixtures such as cabinetry and plumbing products. This obviously ties the demand for their products closely in with the vibrancy of the home building market. Masco considers itself the largest U.S. manufacturer of kitchen and bathroom cabinetry. Their cabinetry products, such as the Kraft Maid brand compete directly with Fortune Brands. Similarly, Masco’s Delta Faucets and other plumbing supplies compete with Moen, also owned by Fortune. Masco has struggled of late due to the drastic slowdown in new home construction. Masco lost nearly one billion dollars in sales, as 2007 revenues of $11.8 billion were down from $12.7 billion the year before.
STOCK PERFORMANCE:
The five year period examined is 11/24/03 through 11/24/08. During that period Masco lost 64.8% of their share value, dropping from $27.20 down to $9.58. Fortune Brand’s stock lost 44.7% over the same period, from $68.32 to $37.80. Although both companies have lost share price value over the past five years, particularly during the recent downturn in new home construction, Masco has fared much worse than Fortune Brands (the more diversified company).
(TICKER SYMBOL NOTE: FO = FORTUNE BRANDS & MAS = MASCO)
PERFORMANCE METRICS:
CONCLUSION (HOME FIXTURES INDUSTRY): The diversified company (Fortune Brands) outperformed the core company (Masco) in all of the examined performance metrics measured for the Home Fixtures industry sample. While both companies have been hurt by the downturn in new home construction, Fortune Brands seems to be better hedged due to their other segments (Distilled Spirits & Golf Products) helping to compensate. Masco seems to be more “feast or famine” based largely upon the volume of new home construction and renovations.
- INDUSTRY – OFFSHORE MARINE SERVICES
DIVERSIFED COMPANY: Seacor Holdings Inc.
Seacor Holdings is a diversified company organized around the following six business segments: Offshore Marine Services, Aviation Services, Marine Transportation Services, Inland River Services, Environmental Services, and Harbor & Offshore Towing Services. The Offshore Marine Services segment is the company’s largest. Seacor Marine operates a large fleet of offshore marine support vessels, primarily serving the offshore oil and gas exploration & production industry. Some of the services offered are: crew transportation, platform supply, maintenance support, and offshore accommodations. Seacor’s aviation services revolve around transporting personnel to offshore oil and gas fields through their Era Helicopter subsidiary. Seacor’s marine transportation subsidiary, Seabulk Tankers, operates a fleet of vessels which transports crude oil, petroleum products and chemicals. Their Inland River service utilizes a fleet of over one thousand barges to transport dry and liquid bulk cargo along inland waterways. The Seacor Environmental Services group offers an array of services including: oil spill response management & clean-up; hazardous material response; waste management, waste water remediation; and pipeline repair services. Finally, their towing segment operates a number of tugboats to assist tankers, container ships and other cargo vessels in docking and proceeding within port harbor areas. The Seacor revenue is segmented among the business units as follows:
CORE COMPANY: GulfMark Offshore
GulfMark Offshore is a niche competitor in the offshore marine services industry. Their core services match up with the Offshore Marine Services business segment of Seacor, and they provide similar services. GulfMark services companies involved in offshore exploration and production of oil and natural gas. They accomplish this through their fleet of 62 vessels. GulfMark has shown steady revenue growth over the past few years and they moved to the New York Stock Exchange on July 20, 2007. Although GulfMark has a growing fleet with seven new vessels currently in the pipeline, Seacor owns and operates a much more diverse fleet of ships to service their varied business operations. GulfMark’s total revenue of $306 million is roughly half of Seacor’s $692 million Offshore Marine Services division.
STOCK PERFORMANCE:
The five year period examined is 11/24/03 through 11/17/08. During that period Seacor gained 35.7% of share value, climbing from $38.17 to $59.27. GulfMark’s stock gained 44.3% over the same period, rising from $14.03 to $25.17. Although both companies have had increasing share price values over the past five years, GulfMark bested Seacor (the diversified company) slightly on a percentage basis.
(TICKER SYMBOL NOTE: CKH = SEACOR HOLDINGS & GLF = GULFMARK OFFSHORE)
PERFORMANCE METRICS:
CONCLUSION (OFFSHORE MARINE SERVICES INDUSTRY): The diversified company (Seacor Holdings) outperformed the core company (GulfMark Offshore) in four of the six examined performance metrics measured for the Offshore Marine Services sample. While both companies have performed relatively well, Seacor has shown higher growth in revenue, net income, cash flow and earnings per share. If a downturn in the offshore marine services market occurs (i.e., if there is a downturn in offshore oil and gas exploration) then Seacor is better positioned to “ride it out” thanks to its other business segments.
CONCLUSION OF ANALYSIS:
The results of this analysis are summarized below using the chosen performance metrics:
The purpose of this analysis was to look for trends in actual financial performances between companies that have chosen either a relatively high or low degree of diversification strategy. The results are quite striking. Overall, the well diversified companies outperformed the less diversified companies by 89% using the chosen metrics. Only one “core” company had a better five year stock price return than their more well diversified partner. The diversified companies outperformed on the growth of net income, cash flow and earnings per share for every industry examined.
There could be a wide range of explanations to explain the divergent performance results. The decision whether or not choose a strategy of business diversification if just one of many critical decisions which must be made by Executive Management. However, the trend from this sample of companies indicates that further research may be warranted.
Diversified companies seemed to be viewed as passé by many investors and others in the business community over recent history. Companies became increasingly more eager to focus all their resources on their core competencies in order to maximize short term financial returns. I believe the current U.S. economic downturn will cause many management teams to consider greater future diversification. Many core financial services companies were nearly wiped out due to the subprime mortgage meltdown, and some did not survive. A virtual freeze in new homes sales and construction has devastated many builders and suppliers of home materials, fixtures and furnishings. Those companies with a more diverse base of operations are naturally hedged against such sudden market downturns and are often better positioned to survive in tough economic times.
This analysis does not conclude that diversification is a better strategy than maintaining a core focus. Every company, industry and situation is unique and warrants individual analysis. This analysis merely attempts to provide some level of “real world” empirical data to the theoretical question of diversification as a prudent business strategy.
FURTHER RESEARCH:
Obviously, any analysis is more convincing with a larger sample size. Further research could include increasing the sample size, using a longer list of financial performance metrics, and including foreign based companies. This same basic approach could be applied to the analysis of other business strategy decisions. For example, many companies have chosen to invest in quality improvement or cost reduction programs such as Six Sigma and TQM over the recent past. Much has been written about the theoretical value of programs such as these. However, for some companies the cost of such programs may have exceeded the net benefit. A comparison of financial results between similar companies that either utilize a formal quality program or not, using actual empirical data, could provide some indication of their actual effectiveness.
REFERNCES AND SOURCES:
Thompson, A.A, Strickland, A.J. & Gamble, J. (2008). Crafting & Executing Strategy: The Quest for Competitive Advantage (16th ed.). New York, NY: McGraw-Hill Irwin.
SOURCE DATA:
The majority of the empirical data and company background information for this analysis was primarily collected from the following sources:
- YAHOO.COM FINANCE: Used for stock price graphs and company stock prices.
- WALL STREET JOURNAL ONLINE: Used for company financials and for the above listed average growth rates, other than stock price growth.
- COMPANY WEBSITES, ANNUAL REPORTS, AND 10K SEC FILINGS: Used to collect business revenue by operating segment data, as well as other background and general company information.